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Tesla: A Carmaker With Silicon Valley Spark

It takes big car manufacturers four years to develop a new model. In that period of time, Tesla Motors Inc. has created a brand-new kind of car company--not to mention plenty of buzz.

Filling the niche for a green vehicle that isn't virtuously homely, Tesla has buyers standing in line to buy its sleek $98,000 electric sports car, which starts coming off the assembly line in October. The wait list now includes George Clooney, California Governor Arnold Schwarzenegger, and Google Inc. (GOOG) founders Larry Page and Sergey Brin. They want to be the first in their neighborhoods to own the eerily quiet machine that can rocket from 0 to 60 in four seconds.

But once the short list of environmentally conscious tycoons trades in their Toyota (TM) Priuses for Tesla Roadsters, will there be enough business for the company to survive? Boutique automakers have a grim history. The last car startup to make it was Walter Chrysler's namesake company in 1925. Many auto industry insiders are impressed with Tesla's technology, but question whether the 250-employee San Carlos (Calif.) company will be able to sell enough cars to thrive in the ultracompetitive global car industry. "These guys look undercapitalized to build cars in real numbers," says James N. Hall, vice-president of AutoPacific Inc., an auto industry consulting firm. "They can sell cars until other, bigger manufacturers start selling vehicles that aren't pure electrics but are green enough."

So what makes Tesla think it has a chance? The very fact that it has been built by outsiders. After all, Detroit is hardly a model of corporate efficiency. Tesla bills itself as Silicon Valley's version of a car company. Importing executives and management ideas from the technology industry, it is handing out stock options to every employee, doing away with independent dealers, and outsourcing the manufacturing of its cars. Almost all of Tesla's $105 million in startup capital has come from wealthy California idealists and venture investors. "Silicon Valley is the best in the world at everything it does," boasts Elon Musk, the PayPal (EBAY) founder who sold the company for $1.5 billion before becoming Tesla's chairman and chief source of funds. "The corporate culture [in the Valley] is extremely efficient and very competitive."

Startup energy radiates from Tesla's converted warehouse space on a side street in middle-class San Carlos. All of the top executives--except Musk, who isn't involved with day-to-day operations--work together in small, cheaply decorated offices. If big decisions need to be made, no one needs to schedule big meetings, write up proposals, or go through any chains of command.

BATTERY POWER

Tesla CEO Martin Eberhard, a former computer engineer, says he is trying to build a car manufacturer that is also a technology company. By outsourcing mundane parts like brakes and seat belts, Tesla engineers are able to focus on a few core technologies: the battery, the computer software, and the proprietary motor that make the car go. Unlike Toyota, General Motors (GM), and Ford Motor (F), whose hybrids use nickel metal hydride batteries, Tesla believes its lithium ion technology will ultimately be cheaper and have more storage capacity.

Lithium ion batteries also happen to be the power source for something people in Silicon Valley know well: the laptop computer. The sophisticated energy storage device that sits in the trunk of the Tesla Roadster is merely a bundle of 6,831 laptop battery cells. Right now this pack costs about $20,000 to produce, about one-fifth of the car's price.

Any hope Tesla has of achieving Eberhard's dream of producing higher volumes of cars annually rests on cutting this cost. The company also is going to have to boost the range of its cars beyond the current maximum of slightly more than 200 miles and provide owners with a reasonably glitch-free product (never an easy thing for a new manufacturer to do). The next vehicle on Tesla's drawing board is a five-passenger sedan code-named White Star. The target price will be from $55,000 to $68,000. In five years, Eberhard wants to be producing a $30,000 electric car known as Blue Star.

Tesla's team is hoping to benefit from a battery technology that is already improving rapidly. The production of laptop cells has tripled in the past five years, dropping the cost of lithium ion batteries down 8% annually. That trend should continue. The company's scientists also are betting they can find ways to use their in-house expertise to adapt lithium ion batteries for use in lawn mowers, motorcycles, and satellites. This will help them achieve efficiencies of scale without waiting for car sales to take off.

The company, which plans to go public next year, has created a second division, Tesla Energy, to sell its energy storage technology the same way Toyota licenses its hybrid systems. Its first customer is Think Nordic, a Norwegian producer of small city cars. Some investors believe this unit may have more potential than the car side of the business.

NO MIDDLEMAN

While Tesla has Silicon Valley roots, it has hired a slew of engineers from the Big Three and installed them in its Michigan development center in Detroit's northern suburbs. Tesla's new hires know they aren't working for "Generous Motors" anymore. John Thomas, senior director for White Star, says his army of Big Auto refugees isn't afraid to fly coach or work long hours. Tesla also pays lower-than-average wages. But since everyone has stock options, they'll reap big rewards if the company succeeds.

Tesla's business model also cuts out independent car dealers. The company plans to have six dealerships in major cities. Each one will have specialty technicians to make any repairs. Since about 10% of a car's sticker price is the dealer's take, Tesla will save money. Plus, the company is going for such low volumes that it won't waste money on advertising, says Darryl Siry, vice-president for marketing. "Porsche spends $1,000 a car on marketing," he says. "I essentially spend zero."

Compared with Big Auto, Tesla's near-term sales goals are modest--just 1,000 a year for the Roadster and 10,000 annually for the future sedan. Eberhard believes they should be easily reachable. He notes that owners of Toyota's Prius earn on average well in excess of $100,000 a year. That means they can afford something much nicer than Toyota's $22,000 hybrid. If necessary, the company would be willing to use a small gas engine to boost Blue Star's range and broaden its appeal.

Musk is convinced there are plenty of customers, like him, who will want something faster or flashier than a Prius. At the moment, in fact, he drives a Porsche and his wife drives a 14-mpg Maserati (FIA) Quattroporte sedan. "I just can't get into the Prius," Musk says.